Oppenheimer Upgrade Shows Bed Bath & Beyond Is Undervalued

| About: Bed Bath (BBBY)

Shares of Bed Bath and Beyond (NASDAQ:BBBY) were up strongly in the last few trading sessions as investors poured into the stock following a breach of $56 a share for the third time in the last 30 days. This article aims at disclosing why shares had been so strong during this time period and why BBBY shares were upgraded by Oppenheimer.

On January 24, 2013, Oppenheimer's Brian Nagel upgraded shares of BBBY to Outperform along with raising the firm's price target to $71 a share from $67 a share. Shares of BBBY soared on news of the upgrade by as much as 5% intraday. Let's take a closer look as to why the analyst took such a strong stance by diving into the research report.

The first and probably most important statement within the Oppenheimer research report reads as follows:

"In our view, sales and EPS weakness at BBBY lately reflects primarily transitory issues and, to a certain extent, the effects of recent, aggressive internal investments and not structural shortcomings".

I would think it is painfully obvious to see through the last couple of quarterly results that BBBY's management has underestimated the impact on quarterly results from the costs associated with the recent acquisitions of Linen Holdings LLC. and Cost Plus. The recent investments the company has made should prove beneficial to the bottom line in the coming quarters as BBBY has proven in the past that it has the "know-how" to develop synergies from acquisitions that become accretive very quickly.

Technically speaking, since September, shares of BBBY have fallen some 21% while the S&P 500 has advanced by roughly 5% respectively.

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This could have been a market bottom for shares of BBBY which basically value the company near the trough bottom recognized in the share price during the financial crisis of 2008. Structurally, nothing is wrong with the company, as proven by the YOY growth in revenues and earnings along side strong free cash flow and zero debt. To have been trading with a P/E of roughly 11 X trailing earnings was a recognizable opportunity for investors. The new price target of $71 a share offered by Oppenheimer represented a 25% increase in the price per share from January 23, 2013. Oppenheimer also lifted its FY13 (Feb. 2014) and FY14 (Feb. 2015) earnings forecasts to $5.05 and $5.95. The average analysts' estimate for earnings in 2012 is $4.56 a share.

Oppenheimer's next analytical point of research denotes the strong share repurchase program the company has offered to investors:

"BBBY has for several years consistently and aggressively repurchased shares (see Exhibit 3 below). Management recently announced a new $2.5B share repurchase authorization. We assume that BBBY will buy back about $850M in stock in each of the next couple of years. Share repurchases should add 3-5% points to EPS growth at the chain in fiscal years 2013 (Feb. 2014) and 2014 (Feb. 2015). We view continued aggressive share repurchases at BBBY as reflective of the company's superior cash generation (free cash flow of nearly $1B annually) and serving as a testament to the underlying confidence of management and the BBBY board in the longer term strategic positioning of the chain".

In my opinion, Mr. Nagel understands the value of the share repurchasing program and believes that many have not appreciated this aspect based on the recent stock price. Since 2004, Bed Bath and Beyond has repurchased $4.7 billion worth of stock. Between the new and the existing share repurchase program, Bed Bath and Beyond has offered to buy back some $2.7 billion worth of shares.

Now let's get directly into sales at Bed Bath and Beyond. Admittedly, sales strength has been anything but robust for a good portion of 2012. However, and I'm paraphrasing, Oppenheimer's Mr. Nagel feels that a good portion of the sales growth deceleration was due to the impact of waning sales from Green Mountain Coffee Roaster (NASDAQ:GMCR) products. The outsized sales impact the company had felt from 2007-2011 experienced some give back in 2012 as Green Mountain continued to expand its retail distribution chain. Additionally, more single-serve k-cup or coffee pods came to market in 2012 offering the consumer alternative choices than the products offered at Bed Bath and Beyond. Investors would also need to recognize that K-cups could easily be found and purchased in more grocery chains during 2012 than every before, thus curtailing K-cup sales at Bed Bath and Beyond. That's the nature of retail folks.

Here is where I'm going to have to disagree with Mr. Nagel's attribution of the sales growth deceleration being felt at Bed Bath and Beyond. While I do recognize the amount of revenue produced from GMCR products being sold through BBBY, surely there has had to be another product offering, if not several product offerings, to takes its place over the recent quarters if not years. Capital Ladder Advisory Group (capitalladders.com) has followed GMCR product sales at BBBY for years now and we have more recently also been tracking sales of a new product category at Bed Bath and Beyond known as the at-home beverage carbonation category.

Bed Bath and Beyond first began selling products in this relatively new category in FYQ4 2010 when it signed a distribution deal to sell SodaStream (NASDAQ:SODA) products. SodaStream manufactures home beverage carbonation systems, which enable consumers to easily transform ordinary tap water instantly into carbonated soft drinks and sparkling water. Much like the GMCR razor/razor blade business model which sells a machine and consumables to create reoccurring sales for BBBY, the SodaStream products offer the same reoccurring sales for BBBY. SodaStream sells a soda maker machine, ½ liter, 1 liter, flavored syrups and CO2 canisters to customers at Bed Bath and beyond. In addition to this product line, Bed Bath and Beyond is the leading national CO2 exchange provider for SodaStream users. Bed Bath and Beyond boasts well over $20 million in sales from the CO2 exchange program alone in fiscal 2012. Capital Ladder Advisory Group believes that much of the waning sales from GMCR products have, at the very least, been mitigated by the continued strength in sales for SODA products. Based on this analysis, I would have to question Mr. Nagel's assumption about sales growth deceleration being more closely attributed to give back from outsized sales of GMCR products. The retail environment will always be populated with new products, competing products and competing prices. Therefore, management's greatest action will be to foresee such impediments in sales growth and act accordingly. I would be of the opinion that the adoption of the SodaStream product line was an example of such foresight by BBBY management and as sales of SODA products grow they will help alleviate the pressures of waning GMCR product sales. Either way, the company should benefit greatly from the growth in household formation going forward as we have seen housing starts data climb over the second half of 2012.

Many investors and analysts have been worried about e-commerce sales impacting brick & mortar retailers. Bed Bath and Beyond's e-commerce sales have been less than stellar over the years as not too many people look to purchase linens on-line. Oppenheimer believes the threat posed by other on-line retailers is "overblown". Mr. Nagel says:

"BBBY is first and foremost a superior merchant that attracts customers to its stores and drives market share gains through a superior and well-displayed product offering. A better developed online offering will enhance the consumer proposition of BBBY and we believe improve sentiment toward shares. The opening of a new e-commerce distribution center and investments made to enhance its existing website should position BBBY well in coming quarters and years".

I'm of the same opinion as Mr. Nagel in this regard as most consumers do not purchase linens on-line but rather other hard-line and electronic goods.

I touched very briefly upon the increased housing demand, which Oppenheimer also recognized in their recent research report as a beneficial reason to upgrade shares of BBBY. In the report, the company outlines how December existing home sales are now tracking at an annual rate of 4.94M and up, more than 12% from prior-year levels. An underlying strengthening housing market should help to drive better sales at home-related retailers. Oppenheimer expects an improving housing market to represent a new driver for BBBY sales in upcoming years. They also estimate that increased housing turnover could add 0.5-1.5% pts. to BBBY's comps in FY13.

Capital Ladder Advisory Group has followed shares of BBBY and the company's developments for over a decade now and deems the retailer the top merchant in the industry. We continue to believe that based on the core fundamentals, shares of BBBY are currently undervalued. Our channel checks indicate that Q4 represented an inflection point in sales that should accelerate going forward. Recognizable growth in the core and newly acquired businesses should add considerable leverage to the overall company and serve to expand margins in 2013, driving net profits higher.

All quoted statements within this article came directly from the most recently released Oppenheimer analyst report on Bed Bath and Beyond. The release date was January 24, 2013 and the report is available to clients of Oppenheimer.

Disclosure: I am long BBBY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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